By accepting the major recommendations of the Parthasarathi Shome Committee on General Anti Avoidance Rules (GAAR), including its deferment, the finance minister has again sent out a positive signal to investors about his commitment to provide a fair and balanced tax regime. Most important, his statement has brought certainty for the industry which, though somewhat comforted by the initial recommendations of the Shome committee, awaited confirmation from the government about its final view.
The Shome committee played a crucial role in laying out the guiding principles for applying GAAR. It comes as no surprise that many of its significant suggestions to limit the scope of GAAR and introduce safeguards against its arbitrary application have been accepted by the government. These include acceptance of main or dominant purpose test for characterising transaction to be impermissible, restricting GAAR’s applicability to the tax consequence of the impermissible part as against the whole arrangement and non-applicability of GAAR to the Foreign Institutional Investors (FIIs) and non-resident investors into FIIs. Also, welcome is the decision to allow taxpayers to obtain advance ruling on application of GAAR or otherwise to a given arrangement.
The FM has indicated that investments made before August 30, 2010, i.e. the date of introduction of the Direct Taxes Code Bill, 2010, will alone be grandfathered. Though the government has not fully accepted the Shome Committee’s recommendation of grandfathering the investment structures till the actual implementation of GAAR, the decision does provide certainty in respect of the investments made till August 2010. A significant safeguard accepted by the FM is that of an independent approving panel. However, the implications of providing that the directions of the Panel would be binding on the taxpayer also, contrary to the Shome committee’s suggestion of making it binding only on the tax authorities, are not clear.
The FM has chosen to remain silent on some of the recommendations by Shome committee. For instance, he does not refer to the suggestion that GAAR provisions should be subject to the overarching principle of tax mitigation distinguished from tax avoidance and that GAAR apply only to artificial, abusive and contrived arrangements. Nor does his statement provide any clarity in respect of the illustrations outlined in the committee’s report that highlight the scope of the mitigation principles. These examples are important as they clearly delineate the transactions where GAAR provisions should or should not be applicable.
It has been provided that where both GAAR and Specific Anti-Avoidance Rules (SAAR) are in force, only one of these will apply. However, the basis on which the selection of GAAR vs SAAR will be made remains unclear. Similarly, the official statement is silent on GAAR applicability in the case of treaties with Limitation of Benefit provisions or in case of Mauritius companies presently covered by the Circular No. 789. The FM has also remained quiet on the committee’s suggestion on abolishing the capital gains on listed securities.
One would like to believe that the silence by the government implies concurrence with the Shome committee’s suggestions on these issues too.
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After the positive policy decisions on GAAR, it now remains to be seen if the administration follows the guidelines suggested by the Shome Committee and if there is adequate clarity on how GAAR shall be applied. Given the inherent subjectivity involved in GAAR application, it does carry the risk of arbitrariness in tax administration. In this context, the role of the approving panel in providing a safeguard is significant. That the panel would be headed by an independent person and include a non-government member are important features to ensure its objectivity. Lack of independence, as is evident from the experience of the Dispute Resolution Panels (DRPs) enacted in the year 2009 to minimise international disputes, can render the Panel ineffective.
India needs significant reforms in tax administration as pointed out by the Shome Committee in its report, international taxation in India is already faced with serious administrative challenges. And, one of these challenges is the ineffectiveness of the alternate dispute resolution mechanisms. Though the government has taken some positive initiatives to facilitate expeditious resolution of tax disputes, the real problem lies in the implementation of these decisions.
The most obvious example is that of the Dispute Resolution Panels (DRPs), which have the potential to be a very effective mechanism to deal with transfer pricing controversy and other international tax disputes. However, there are significant implementation gaps that need to be addressed to make their functioning more effective. DRPs are lacking in autonomy and independence and in most instances only confirm the assessment of tax authorities which get appealed by the taxpayer at tribunals and higher levels of judicial process. They have failed in their objective of resolving and settling disputes without resorting to litigation.
The Rangachary Committee on Taxation of Development centres in India was also meant to address the high volume of disputes through alternate means such as guidelines for TP assessments and safe harbour rules. The industry eagerly awaits the Committee’s recommendations and the Minister’s final view on the same.
The finance minister has promised the investors of bringing clarity in tax laws along with a non adversarial tax administration and a fair mechanism for dispute resolution. The new avatar of the GAAR provisions would go a long way in minimising GAAR dispute, which would have multiplied several fold, if it were enacted in its original form in the budget. Now, the minister should turn to other measures to reduce the ever growing volume of tax disputes.
The author is tax partner, Ernst & Young. Views expressed are personal.
Shalini Mathur, senior tax professional, also contributed to the article